Long odds of US success for this ASX favourite

Pointsbet ASX: PBH announced a 52% revenue increase to $297 million for FY22.

It’s burning through cash though and declared losses of just under $244 million. The focus has been on laying the groundwork for earnings in a few years. Think new operation launches across the US, a $400 million capital raise, investment from SIG Sports Investment Corp, integrated marketing campaigns and a celebrity spokesman (hi Shaq!). None of this comes cheap.

There is definitely an enormous market opportunity in the US if you take a long term view on Pointsbet. Even if they don’t achieve their stated 10% market share target and land at around 5%, it’s still going to be a very successful and very profitable company.

In this wire, Michael shares some of the highlights from Pointsbet’s FY22 result, and gives us his outlook on the company and its sector for the year ahead.

Pointsbet (ASX: PBH) FY22 key results

Note: This interview took place on Wednesday 31 August. Pointsbet is held by some clients of Medallion Financial Group. 

What were the key takeaways from this result? What surprised you the most?

The result was ok, but what surprised us the most and what we’ve been monitoring over the last 12 months is their market share. The company has stated that it is looking to achieve a 10% market share across all the states in which it operates in the US. Over the last 12 months, we’ve seen market share in a lot of those states actually decline. That’s a bit of a concern for the market and one of the many reasons the share price has come under pressure.

To give you some perspective, at Q2 FY22, the overall market share across the US was about 4.2%. That’s dropped down to 3.7%. Going back 12 months ago, they had 4-5 states with market share above 5%. That’s dropped off and they’ve only got one state (Illinois) where their market share is above 5%.

It hasn’t been a complete surprise because they’ve been losing market share continually but it’s definitely something we’ve been monitoring. We’re surprised at how quickly market share has dropped off in some of those states. For example, they had close to 8% market share in New Jersey 12 months ago. It’s now 2.6%. It’s an extreme example that demonstrates what is going on with their market share targets.

The rate the company is burning through money is a little bit of a surprise. We know they’re not planning to be profitable anytime soon. 

There is a bit of a land grab going on in North America for the sports betting market. They’re spending a lot of money to try and win business and market share. At the same time, they’re burning through a lot of cash and they’ve posted an EBITDA loss of $A243.58m. The magnitude of that loss is concerning to us and probably the rest of the market as well.

They’ve done a couple of sizable capital raisings in the past. They’ve also signed strategic partnerships with NBC and SIG Sports Investment Corp. That’s given them a lot of cash on their balance sheet. But at the rate they’re burning through that, they’re going to have to raise again. That’s either going to be through a dilutive capital raising on market or they’ll have to go out and find another strategic partner.

What was the market’s reaction to this result? Was this an overreaction, an under reaction or appropriate?

At market open, it was down around 5% or so. It’s gotten worse as the day’s gone on and analysts have had more time to interpret the numbers. It’s down now about 10%. It’s probably a fair reaction, particularly in this environment that we find ourselves in more broadly.

What we’ve found for the last 3-6 months is those businesses that are burning through cash are really getting harshly dealt with. Those companies with short-duration cashflows – that is generating nice cash numbers and earnings – are less harshly dealt with compared to those where cashflows are expected to kick in 4-5 years down the track. A lot of the value is embedded in those future cashflows.

Would you buy, hold or sell Pointsbet on the back of these results?

HOLD

We do have clients who hold Pointsbet and were fortunate to pick it up around the $2 mark. At one point, Pointsbet was up around $15 a share and that’s when they first launched into the US market. They were seeing some very good initial numbers. The market was probably overexcited on the upside. The market tends to overact on the upside and then overact on the downside as well. I think today’s value is more or less fair value.

There is definitely an enormous market opportunity in the US if you take a long-term view on Pointsbet. Even if they don’t achieve their stated 10% market share target and land at around 5%, it’s still going to be a very successful and very profitable company.

If they’re able to achieve numbers somewhere in between where they are now and where they hope to be, shareholders will do well over time. It’s always difficult to say in the short term. The share price is up considerably from lows in June but still a long way away from those all-time highs. I would caution investors not to expect that the company share price will recover to previous levels anytime soon. 

I’d give it a hold for investors looking for exposure to the US online gaming market. 

Then I think you need to be patient because these numbers will have to wash through the market. I think you might get further selling pressure after today’s results.

What’s your outlook on Pointsbet and its sector over FY23?

I’ll start with the broader sector.

The US, quite a sports-centric country, had a nationwide ban on sports betting right up until 2018. There was a Supreme Court ruling which legalised sports betting and handed it over to the States to determine whether or not to allow it. More and more have deregulated their sports betting industries over the year and that’s allowed companies like Pointsbet to move into the space. Pointsbet operates in 10 different states with approval to operate in a couple more.

There’s a huge land grab going on with different sports spending companies trying to get their piece of the pie. That’s what’s creating this big “spend now, earn the money later” metric you’re seeing. There are a lot of different players in the industry. It’s a huge market. It dwarfs the Australian market despite how betting mad we are in this country. Pointsbet is up against some big names like DraftKings (NASDAQ: DKNG) and Flutter Entertainment (LON: FLTR). In Pointsbet’s favour, they did have first mover advantage in a lot of these places – or they’re amongst the top few to enter. This allowed them to build a reputation and some notoriety. They also own 100% of their tech stack which is something a lot of other competitors can’t say. According to independent surveys, their overall ranking is very strong in terms of platform usability.

We still like the outlook for the broader sports betting space in the US. We’re happy to back that view long-term. For that reason, we do have clients that hold it. We would caution it’s a very high-risk space at the moment because a certain theme is playing out. 

Not all the companies involved will be beneficiaries. You’ll get winners, you’ll get losers and you’ll get some that even go by the wayside. We feel that Pointsbet is in with a fighting chance. 

They’re not as large as some of their competitors there which means they don’t have as much to spend on the marketing side of things. They don’t necessarily have access to rivers of cash like some of their competitors. It’s going to be a challenge for them. We think they’re in with a shot to at least establish a decent foothold in the space.

It’s a speculative hold for us on a long-term thematic and certainly not a business for everyone.

Are there any risks to this company and its sector that investors should be aware of given the current market environment?

There are definitely broader market risks.

It’s no secret that the market is looking harshly at growth-type businesses. That could continue for some time if inflation persists and interest rates continue to get ratcheted up higher.

Then there are company-specific risks. Can they execute their strategy? Are they going to be able to get anywhere near the 10% market share by 2025 that they’re aiming for? It looked a lot more likely 12-18 months ago than it does today.

Investors’ fortunes are going to fluctuate as Pointsbet’s numbers came out and Pointsbet’s ability to win market share fluctuates.

The ability to raise capital is going to be an ongoing issue for them. They might be able to raise capital to fund further marketing and market share initiatives, but the question is at what dilution and dollar value are they going to raise capital at? An extremely dilutive capital raising will send the share price lower for example.

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

Rating = 3

It’s a tough question because when you look at the ASX at face value, it looks somewhat cheap. The market PE ratio is around 13.5-14x earnings and the long-term average is around 15x. If you take out the two biggest sectors of the ASX – financials and mining companies – the PE ratio of the market jumps to 20x. On that basis, it doesn’t look overly cheap. The dividend yield is around 5% but a lot of those dividends have been driven by the big miners. There are question marks about the sustainability of that going forward.

We remain cautious on the market because it can always get cheaper given the current environment of high inflation and rising interest rates. 

It looks like many analysts are revising expectations lower for next year’s earnings and that will put downward pressure on earnings across the market. In the short term, it will increase the PE ratio of the market. Keep in mind that markets will probably start to look more expensive once these analyst earnings downgrades are factored in.

We are fairly neutral on the market. We see it as fairly valued at the moment. It’s not blatantly cheap and it’s not as expensive as it was 6-12 months ago.

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